Monetary Policy and the Pending Minsky Moment

As reported here, recently the IMF posited a “Minsky Moment” is pending in the US, due to current-account trade deficits. The foreign-capital inflows are bloating US asset values into a towering house of cards which could soon tumble on the next windy day.

In this regard, the IMF links arms with the tenacious tight-money crowd, which has a default position that loose money has bloated US asset values into a skyscraper anchored in quicksand.

After the Pending Financial Debacle

Having hunkered down in my hardened financial bunker, I read with interest a N. Gregory Mankiw New York Times op-ed regarding our emasculated US Federal Reserve.

The Dodd-Frank bank “reform” legislation is a many-splendored poison it would seem, but among its most-potent toxins was a proviso that the US Federal Reserve can no longer “bail out” banks.

Yet by many accounts, banks are no less prone to widespread failure now than in 2008, with reserves hardly higher.

Mankiw ponders this, thusly: “Central banks like the Fed have two tasks. The first is to adjust the money supply and interest rates as economic conditions change. The second is to help ensure the safety and soundness of the financial system. As part of this second task, central banks sometimes need to act as a lender of last resort.”

Mankiw says due to short-term repurchase agreements and other short-term liabilities, gigantic financial institutions can yet experience “bank runs” and seize up.

Worse, runs beget runs.  And private-sector financial “insurance”? Well, see AIG for how that works out. (AIG insured bonds and other financial instruments, and collapsed in 2008).

In the pending financial debacle, under Dodd-Frank the Fed will have to stand by idle, the financial fire truck without hoses.  (Possibly after having started the fire by playing with tight-money match-sticks, btw).

Bank Bail-Outs

While there is justifiable animus towards bank bailouts, perhaps if one posits that if bank shareholders get wiped out first, and then bond-holders, then a bank bail-out is a good macro-prudential policy.

It is up to the bank board of directors to protect shareholders, and keep any publicly held bank on a prudent course. If they fail, then bondholders assume equity, push the old board out along with management and old shareholders, and take over.  Is this really moral hazard?

If a bank still fails, then a government-assisted bank work-out, merger or bailout is an option, and a very valuable option if banks are flopping left and right.

A burning neighborhood is no time for extended ideological debates on whose fault is the fire. The Fed must have fire-hoses.

Conclusion

Well, the good news is that if the US does have a 2008 repeat, probably Dodd-Frank will be pushed over by emergency legislation, or the Fed will just soft-shoe around the law anyways (as some say it did in 2008).

But it would be better if enabling legislation were in place now.

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